Derivative Financial Instruments

3 Months Ended

Mar. 31, 2015

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

DERIVATIVE FINANCIAL INSTRUMENTS

Heartland uses derivative financial instruments as part of its interest rate risk management strategy. As part of the strategy, Heartland considers the use of interest rate swaps, caps, floors and collars and certain interest rate lock commitments and forward sales of securities related to mortgage banking activities. Heartland's current strategy includes the use of interest rate swaps, interest rate lock commitments, and forward sales of mortgage securities. Heartland's objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates. The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amounts to be exchanged between the counterparties. Heartland is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. Heartland minimizes this risk by entering into derivative contracts with large, stable financial institutions. Heartland has not experienced any losses from nonperformance by these counterparties. Heartland monitors counterparty risk in accordance with the provisions of ASC 815. In addition, interest rate-related derivative instruments generally contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty. Heartland was required to pledge $5.2 million and $5.3 million of cash as collateral at March 31, 2015, and December 31, 2014, respectively. Heartland's counterparties were required to pledge $0 at both March 31, 2015, and December 31, 2014, respectively.

Heartland's derivative and hedging instruments are recorded at fair value on the consolidated balance sheets. See Note 8, “Fair Value,” for additional fair value information and disclosures.

Cash Flow Hedges

Heartland has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. To manage the interest rate risk related to the variability of interest payments, Heartland has entered into various interest rate swap agreements. Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are received or made on Heartland's variable-rate liabilities. For the three months ended March 31, 2015, the change in net unrealized losses on cash flow hedges reflects changes in the fair value of the swaps and reclassification from accumulated other comprehensive income to interest expense totaling $564,000. For the next twelve months, Heartland estimates that cash payments and reclassification from accumulated other comprehensive income to interest expense will total $2.3 million.

Heartland executed an interest rate swap transaction on April 5, 2011, with an effective date of April 20, 2011, and an expiration date of April 20, 2016, to effectively convert $15.0 million of its newly issued variable rate amortizing debt to fixed rate debt. For accounting purposes, this swap transaction is designated as a cash flow hedge of the changes in cash flows attributable to changes in one-month LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on an amount of Heartland's debt principal equal to the then-outstanding swap notional amount. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swap.

Heartland entered into three forward starting interest rate swap transactions to effectively convert Heartland Financial Statutory Trust IV, V, and VII, which total $65.0 million, as well as Morrill Statutory Trust I and II, which total $16.2 million, from variable rate subordinated debentures to fixed rate debt. For accounting purposes, these five swap transactions are designated as cash flow hedges of the changes in cash flows attributable to changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $81.2 million of Heartland's subordinated debentures that reset quarterly on a specified reset date. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swaps.

During the first quarter of 2015, Heartland entered into two additional forward starting interest rate swaps. The first forward starting interest rate swap transaction relates to Heartland's $20.0 million Statutory Trust VI, which will convert from a fixed interest rate subordinated debenture to a variable interest rate subordinated debenture. The effective date of the interest rate swap transaction is June 15, 2017, and Heartland Statutory Trust VI will effectively remain at a fixed interest rate. The forward-starting swap transaction expires on June 15, 2024. The second forward starting interest rate swap is effective on March 1, 2017 and will replace the current interest rate swap related to Heartland Statutory Trust VII upon its expiration on March 1, 2017.

The table below identifies the balance sheet category and fair values of Heartland's derivative instruments designated as cash flow hedges at March 31, 2015, and December 31, 2014, in thousands:

	Notional Amount		Fair Value			Balance Sheet Category	Receive Rate		Weighted Average Pay Rate		Maturity
March 31, 2015
Interest rate swap	$	10,020	$	(209	)	Other Liabilities	2.926	%	5.140	%	04/20/2016
Interest rate swap	25,000		(910		)	Other Liabilities	0.271	%	2.255	%	03/17/2021
Interest rate swap	20,000		(1,001		)	Other Liabilities	0.262	%	3.220	%	03/01/2017
Interest rate swap	20,000		(1,932		)	Other Liabilities	0.254	%	3.355	%	01/07/2020
Interest rate swap	10,000		(143		)	Other Liabilities	0.269	%	1.674	%	03/26/2019
Interest rate swap	10,000		(141		)	Other Liabilities	0.271	%	1.658	%	03/18/2019
Interest rate swap	20,000		(93		)	Other Liabilities	1.632	%	2.390	%	06/15/2024
Interest rate swap	20,000		(107		)	Other Liabilities	1.474	%	2.352	%	03/01/2024
December 31, 2014
Interest rate swap	$	10,369	$	(248	)	Other Liabilities	2.915	%	5.140	%	04/20/2016
Interest rate swap	25,000		(534		)	Other Liabilities	0.243	%	2.255	%	03/17/2021
Interest rate swap	20,000		(1,046		)	Other Liabilities	0.234	%	3.220	%	03/01/2017
Interest rate swap	20,000		(1,748		)	Other Liabilities	0.232	%	3.355	%	01/07/2020
Interest rate swap	10,000		(35		)	Other Liabilities	0.255	%	1.674	%	03/26/2019
Interest rate swap	10,000		(35		)	Other Liabilities	0.243	%	1.658	%	03/18/2019

The table below identifies the gains and losses recognized on Heartland's derivative instruments designated as cash flow hedges for the three months ended March 31, 2015, and March 31, 2014, in thousands:

	Effective Portion							Ineffective Portion
	Recognized in OCI			Reclassified from AOCI into Income				Recognized in Income on Derivatives
	Amount of Gain (Loss)			Category	Amount of Gain (Loss)			Category	Amount of Gain (Loss)
Three Months Ended March 31, 2015
Interest rate swap	$	39		Interest Expense	$	(57	)	Other Income	$	—
Interest rate swap	(376		)	Interest Expense	(126		)	Other Income	—
Interest rate swap	45			Interest Expense	(151		)	Other Income	—
Interest rate swap	(184		)	Interest Expense	(160		)	Other Income	—
Interest rate swap	(108		)	Interest Expense	(35		)	Other Income	—
Interest rate swap	(106		)	Interest Expense	(35		)	Other Income	—
Interest rate swap	(93		)	Interest Expense	—			Other Income	—
Interest rate swap	(107		)	Interest Expense	—			Other Income	—
Three Months Ended March 31, 2014
Interest rate swap	$	51		Interest Expense	$	(65	)	Other Income	$	—
Interest rate swap	146			Interest Expense	(146		)	Other Income	—
Interest rate swap	62			Interest Expense	—			Other Income	—
Interest rate swap	114			Interest Expense	(151		)	Other Income	—
Interest rate swap	(81		)	Interest Expense	(159		)	Other Income	—
Interest rate swap	45			Interest Expense	—			Other Income	—
Interest rate swap	45			Interest Expense	—			Other Income	—

Mortgage Derivatives

Heartland also has entered into interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans and mortgage backed securities that are considered derivative instruments. The fair value of these commitments is recorded on the consolidated balance sheets with the changes in fair value recorded in the consolidated statements of income as a component of net gains on sale of loans held for sale. These derivative contracts are designated as free standing derivative contracts and are not designated against specific assets and liabilities on the consolidated balance sheets or forecasted transactions and therefore do not qualify for hedge accounting treatment.

The table below identifies the balance sheet category and fair values of Heartland's derivative instruments not designated as hedging instruments at March 31, 2015, and December 31, 2014, in thousands:

	Balance Sheet Category	Notional Amount		Fair Value
March 31, 2015
Interest rate lock commitments (mortgage)	Other Assets	$	208,915	$	6,875
Forward commitments	Other Assets	115,352		404
Forward commitments	Other Liabilities	331,161		(1,873		)
December 31, 2014
Interest rate lock commitments (mortgage)	Other Assets	$	74,863	$	2,496
Forward commitments	Other Assets	88,484		275
Forward commitments	Other Liabilities	218,337		(1,619		)

The table below identifies the income statement category of the gains and losses recognized in income on Heartland's derivative instruments not designated as hedging instruments for the three months ended March 31, 2015, and March 31, 2014, in thousands:

	Income Statement Category	Year-to-Date Gain (Loss) Recognized
Three Months Ended March 31, 2015
Interest rate lock commitments (mortgage)	Net gains on sale of loans held for sale	$	5,544
Forward commitments	Net gains on sale of loans held for sale	(125		)
Three Months Ended March 31, 2014
Interest rate lock commitments (mortgage)	Net gains on sale of loans held for sale	$	1,882
Forward commitments	Net gains on sale of loans held for sale	(1,142		)